Wed1015 1115 communitybankingupdate

COMMUNITY BANK TAX & GAAP UPDATE

MOSS ADAMS LLP

RANDY J. CHURCHILLKRISTINE HOEFLINLOUISE HANSON

COMMUNITY BANK TAX UPDATE 2014

The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice.

This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services.

If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought.

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COMMUNITY BANK TAX UPDATE 2014

MAJOR TOPIC AREAS TO DISCUSS TODAY• METHODS OF ACCOUNTING FOR COMMUNITY BANKS• MY 5 FAVORITE METHODS PLANNING ITEMS• IRS EXAMINATION UPDATE • MY 5 FAVORITE IRS EXAMINATION PLANNING ITEMS• TRANSACTIONS: WORDS OF ADVICE• CORPORATE ATTRIBUTES AND PLANNING (FORWARD)• MY 5 FAVORITE TRANSACTIONS PLANNING ITEMS• TAX RATE PLANNING• NOTES ON BASEL III (COVERED IN OTHER SESSIONS)

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Accounting Methods

Frequent Method Changes in 2013-2014 Bad Debts Issues Revenue Procedure 2014-16 Accrued Bonus

• Field Attorney Advice (FAA) 20134301F;• Revenue Ruling 2011-29;• Chief Counsel Advice (CCA) 201246029

Prepaid Expenses – Revenue Ruling 2012-1 FDIC Assessment – Chief Counsel Advice 201311021

Frequent Method Changes 2013-2014

Bad Debts:• Bad Debt Conformity Election (election and revocation)• Changes to Section 166 Bad Debt Method (Voluntary or Not) Depreciation Changes: Asset Scrub, Cost Segregation Deduction of Intangibles vs. Deferral OREO Costs Deduction of Intangibles vs. Deferral Cash to Accrual Change from Accrual to Cash/Hybrid (S Corp. Banks) Accrual of Interest on Nonperforming Loans Credit card fees

Frequent Method Changes 2013-2014

• Employee Compensation• Medical Benefits• Accrued Bonuses• Vacation Pay

• Mark to Market• OID (De minimis)• Market Discount/Revocation of Periodic Election

Revenue Procedure 2014-16

The IRS recently issued Rev. Proc. 2014-16 describing the procedures to obtain automatic consent for changing to accounting methods required or permitted under the “repair” final regulations;

The final regulations are effective for tax years beginning on or after Jan. 1, 2014, but taxpayers may generally apply them to tax years beginning on or after Jan. 1, 2012.

Taxpayers may apply the temporary repair regulations issued in 2011 to tax years beginning on or after Jan. 1, 2012, and before Jan. 1, 2014.

Rev. Proc. 2014-16 supersedes Rev. Proc. 2012-19, which was released following the issuance of the temporary regulations.

Rev. Proc. 2014-16 also updates Rev. Proc. 2011-14 to include procedures to obtain automatic consent for certain changes in accounting methods involving acquisitions, production, and improvements of tangible property.

Rev. Proc. 2014-16 does not address dispositions; they are addressed in a separate revenue procedure.


Section 3.02 of Rev. Proc. 2014-16 adds new Section 10.11 to the appendix of Rev. Proc. 2011-14 to permit automatic consent for changes to:• Deducting amounts paid or incurred to acquire or produce non-incidental materials and

supplies for the first year in which the materials or supplies are used or consumed in the taxpayer’s operations (Treas. Regs. Secs. 1.162-3(a)(1) and 1.162-3(c)(1));

• Deducting amounts to acquire or produce incidental materials and supplies in the tax year in which they are paid or incurred (Treas. Regs. Secs. 1.162-3(a)(2) and 1.162-3(c)(1));

• Deducting amounts paid or incurred to acquire or produce non-incidental rotable and temporary spare parts in the tax year in which the taxpayer disposes of the parts (Treas. Regs. Secs. 1.162-3(a)(3) and 1.162-3(c)(2));

• Using the optional method of accounting for rotable and temporary spare parts (Treas. Regs. Sec. 1.162-3(e)); or

• Deducting amounts paid or incurred for repairs and maintenance, including a change in the classification of a unit of property, or, in the case of a building, a change in identifying the building structure or building systems (Treas. Regs. Secs. 1.162-4 and 1.263(a)-3(e)).


The appendix revisions also apply to:

• Capitalizing amounts paid or incurred for improvements to tangible property, including a change in the classification of a unit of property or, for a building, a change in identifying the building structure or building systems (Treas. Regs. Sec. 1.263(a)-3);

• By dealers in property, deducting amounts paid or incurred for commissions and other transaction costs that facilitate the sale of property (Treas. Regs. Sec. 1.263(a)-1(e)(2));

• By non-dealers in property, capitalizing amounts paid or incurred for commissions and other costs that facilitate the sale of property (Treas. Regs. Sec. 1.263(a)-1(e));

• Capitalizing amounts paid or incurred to acquire or produce property, and, if depreciable, to depreciating such property under Sec. 167 or 168 (Treas. Regs. Sec. 1.263(a)-2)); or

• Deducting amounts paid or incurred in the process of investigating or pursuing the acquisition of real property (Treas. Regs. Sec. 1.263(a)-2(f)(2)(iii)).

Revenue Procedure 2014-16 Revenue Procedure 2014-16 also includes a new automatic change from the

capitalization to the current expensing method of tax accounting for the acquisition and holding period costs incurred on non-income producing foreclosed real property (e.g. other real estate owned)

• Section 2.10 of the Revenue Procedure states:• “…this revenue procedure adds section 11.10 to the APPENDIX to provide automatic consent for a change in

method of accounting to an otherwise permissible method of accounting that does not capitalize under section 263A(b)(2) amounts for acquiring or holding real property obtained through a foreclosure proceeding, a deed-in-lieu of foreclosure transaction, or another similar transaction.”

• “Real property acquired through foreclosure. (1) Applicability. This change applies to a taxpayer that capitalizes costs under section 263A(b)(2) and § 1.263A-3(a)(1) to real property acquired through foreclosure, or similar transaction, where the taxpayer wants to change its method of accounting to an otherwise permissible method of accounting under which the acquisition and holding costs for real property acquired through foreclosure, or similar transaction, are not capitalized under section 263A(b)(2) and §1.263A-3(a)(1). To qualify for this change in method of accounting, a taxpayer must:

• (a) originate, or acquire and hold for investment, loans that are secured by real property; and

• (b) acquire the real property that secures the loans at a foreclosure sale, by deed in lieu of foreclosure, or in another similar transaction.

Revenue Procedure 2014-16 Banks that have been capitalizing both foreclosure costs and holding period costs will need to

include both costs in the accounting method change. In addition, banks that have only capitalized foreclosure costs will want to file a Form 3115 to change that method to the current expense method.

• Banks under Examination. The suspension of the scope limitations in sections 4.02(1) through (4) and (7) of Revenue Procedure 2011-14 for 2013 and 2014 allows banks that are under examination, and banks that have had other changes of accounting within the last five years, to make this automatic change immediately.

• Where to File Change in Accounting Method. Note that the signed copies of the Forms 3115 filed pursuant to Revenue Procedure 2014-16 are filed with the Ogden Service Center rather than the National Office. At this point, it appears that only Forms 3115 pursuant to Revenue Procedure 2014-16 are to be filed in Ogden. All other Forms 3115, such as elections of the Conformity Method of accounting for bad debts, would still be sent to the National Office.

• OREO under Construction. The exclusion for costs capitalized under Section 263A(b)(1) and Regulation 1.263A-2(a)(1) relates to real or tangible personal property produced by the taxpayer for use in its own trade or business or for resale. Presumably, the Service is making clear that if a bank forecloses on real property and then must complete construction, install utilities, or make other material changes to the OREO in order to make it salable, this automatic change of method does not permit those costs to be deductible. Costs of acquiring the property and costs of holding the property until construction started would still appear to be deductible.

Accrued Bonus

The Internal Revenue Code (Sec. 461) allows accrual-basis taxpayers to deduct accrued bonuses (excluding related party transactions) if the following four conditions are met:• All events must have occurred to establish the fact of the liability by year-

end;• The amount of the liability must be determinable with reasonable accuracy

by year-end;• Economic performance must occur by year-end; and• Payment must be made within 2 ½ months of year-end.

Accrued Bonus

Most community banks have applied these provisions by treating forfeiture provisions that might cause an employee to forfeit the bonus as a condition subsequent that would not prevent the bonus from accruing at year-end.

Others banks have simply focused on whether the bonus payments were made within 2 ½ months of year-end while ignoring the other three requirements.

Both approaches are wrong and create significant audit risk (federal and state): • Have you looked at your incentive plans lately?• Have you addressed any risks by:

• Updating the plan documents to comply with the IRS interpretation of the IRC Sec. 461 and IRC Sec. 404; Or

• Consider changing the accounting method (automatic change) via Form 3115?

Accrued Bonus CCA 201246029. CCA identified that the critical element of the analysis was that the bonus

amounts actually be paid to employees and not revert to the taxpayer. Therefore, elimination of the reversion of unpaid bonuses back to the company and reallocation of those bonuses to other employees would enable the bonus pool to qualify as a fixed obligation (if created prior to year-end);

Rev. Rul. 2011-29. In Rev. Rul., IRS considered a situation in which the terms of the employer’s bonus plan required that an aggregate minimum bonus amount be determined by year-end with the allocation to individual employees to be determined after year-end. The plan also provided that any bonus allocable to an employee who had left the company before the bonus had been paid would be reallocated to other eligible employees. The IRS concluded, based on these facts, that the minimum bonus amount determined under the plan could be accrued at year-end if paid by the 15th day of the third month following year-end. This ruling reverses a previous ruling which reached a contrary conclusion, requiring that amounts to be paid to individual employees be determined by year-end.

Rev. Proc. 2011-14. IRS also made it very clear in the ruling that taxpayers must follow the accounting method change procedures in Rev. Proc. 2011-14 to change to the method described in Rev. Rul. 2011-29. Such filings would generally provide taxpayers with back-year audit protection and a four year spread of any unfavorable catch-up adjustment that results from the method change. A favorable catch-up adjustment can be taken into account in full in the year of change. Companies that do not currently have a bonus plan with provisions similar to those in Rev. Rul. 2011-29 may modify their plans after filing the method change to secure back-year audit protection for the old plan.

Accrued Bonus - FAA 20134301F Can the IRS Make it Even More Confusing?

Plan Design Includes a “Must Be Present to Win” Provision

All Those Employed atYear’s End Get the Bonus

Individual performance assessment conducted post year end

If bonus forgone is not reallocated to other participants no deduction would be allowed or allowable

Problem: Without reallocation provisions, the liability is not fixed at year’s end.

Compensation committee has discretion to reduce the bonus pool or adjust the metrics post year‐end (very common in practice)

Problem: the pool is not fixed at the year’s end.

Problem: because the entire bonus pool is not fixed at the year’s end this will likely cause issues under IRC Sec. 162(m) under the “negative discretion” provisions.

Objective bonus pool –performance is measured at year’s end even though the final bonus computations may take place after year’s end

IRS created uncertainty as it is not clear under what circumstances a requirement for board certification prior to payment is considered “ministerial”.

Accrued Bonus

Taxpayers that are not properly accounting for their accrued bonuses under the new IRS guidance may have significant tax liability exposure that could result in financial statement disclosures (e.g. FIN 48 Reserve and UTP Disclosure on the Tax Return). • This exposure can be addressed by filing accounting method change (e.g.

Form 3115) that would generally provide back-year audit protection. • Bonus plans may also be restructured to maximize the amount of

qualifying year-end bonus accruals. • The plan(s) would have to be revised with the assistance of an attorney, reviewed

by a tax advisor for tax consequences, including IRC Sec. 409A compliance; and, reviewed and approved by the Board;

• The Bank will need to develop internal policy and implement milestones if 2.5 month deductions are taken on the return.

Prepaid Expenses

Revenue Ruling 2012-1 addresses and clarifies the issue of materiality and the matching of the income and expense for tax purposes.

Taxpayers must use an accounting method for tax purposes that clearly reflects income and deductions. Treasury Regulation 1.461-1(a)(2)(i) provides that an expense is deductible under the accrual method in the tax year when:

1. All events establishing the liability occur.2. The amount of liability can be determined with reasonable accuracy.3. Economic performance occurs.

Prepaid Expenses

An exception to the economic performance rules allows certain recurring items to be treated as incurred during the tax year even though economic performance has not yet occurred. The exception applies when all of the following have been met:• The all-events test is met (see requirement 1 and 2 on the previous slide) .• Economic performance occurs by the earlier of the 15th day of the ninth

month after the tax year end, or the date of the timely filed return (including extensions).

• The item is recurring in nature, and similar items are consistently treated as incurred in the tax year in which the all-events test is met.

• Either the item is not material or accruing the item in the year in which the all-events test is met results in a better matching of income than would result if the item were deducted in the year of economic performance.

Prepaid Expenses

The ruling limits the application of the “recurring item exception” for prepaid expenses that are capitalized for book purposes. The ruling prevents the advance deduction of prepaid service contracts that represent routine service agreements as opposed to services to be provided under “unique and irregular circumstances” (i.e., disaster recovery, unexpected breakdowns, etc.).

Items that meet the definition of “recurring item”• A liability under a warranty or service contract in which the taxpayer enters into in

connection with property purchased or leased, pursuant to which the other party to the contract promises to repair or replace the property under specified circumstances…

• A liability for general services, which are provided on an ongoing and recurring basis. For these types of contracts, economic performance occurs over the term of the agreement, as services are provided. Further analysis is then required to determine if the recurring item exception applies…

FDIC Assessment

CCA 201311021 - objection to an advance deduction for any portion of the 36 month prepaid FDIC assessment paid in 2009 under the “12 month rule” of Reg. §1.263(a)-4(f).• The IRS ruled that the entire assessment was a single prepaid

amount;• Furthermore, the payment did not constitute 13 separate

prepayments of quarterly FDIC assessments;• Therefore, no portion of the prepayment would qualify for advance

deduction under the 12 month rule; and, thus not deductible.

Most banks had already given up on this position

Bad Debt Conformity Election: FACTS, MYTHS

Election – elective method• Bank-by-bank election;• Need not be made by all “bank” members of an affiliated group;• The election constitutes the adoption of a method of accounting;

• No advanced permission needed to make the election• No IRC Sec. 481(a) adjustments are required or permitted;• Form 3115, Application for Change in Accounting Method, is required

• The election is made by following the procedures set forth in regulation §1.166-2(d)(3)(C);

• New Banks only needs to attach an election statement to the return• Bank must satisfy express determination requirement for the year of the

election;• Bank is only entitled to a deduction for loans classified as “loss assets” for

regulatory purposes.

Bad Debt Conformity Election

Election, in theory, is intended to reduce some of the historic disagreement between taxpayers and the IRS over the timing of bad debt deductions for loan losses;

The election should provide some protection for banks that historically limited the bad debt deduction to net charge-offs;

The election requires the bank to secure an “express determination letter” from the primary federal regulator for every examination cycle.

Banks federal supervisory authority must expressly determine that the bank maintains and applies loan loss classification standards consistent with the regulatory standards.


Revoking the Election• Automatically

• Bank fails to obtain the express determination letter• By the Internal Revenue Service

• The Commissioner has the authority to revoke the election if and when the bank has taken charge-offs and deductions substantially in excess of those warranted by (i) either reasonable business judgment; or (ii) regulatory standards of the bank’s supervisor.

• Voluntarily• Bank may revoke the election if it applies for and receives consent to revoke the

election from the Commissioner via timely filed Form 3115, Application for Change of Accounting Method.


Making the Election – why would you NOT want to elect?• Safe harbor treatment of non-accrual loan interest (e.g. forgone interest)

pursuant to Revenue Ruling 2007-32: REALITIES AND MYTHS• Taxpayer must formally record the non-accrual interest as a “charge-off” on the

tax return;• IRS Audit protection (in theory but in practice the IRS can and will audit the

bad debts) IS A MYTH• The bad debt deduction is generally equal to the charge-offs, net of

recoveries: ISSUES RISING ON BAD DEBTS ALLOWED IN ACTUALITY• loans must be classified as “loss assets” for regulatory purposes – CREATES

ISSUES FOR OTHER CLASSIFIED ASSETS

Bad Debt Conformity Election Revoking the Election – why would you want to revoke?

• The safe harbor for non-performing loan interest now available under the election may cause a bank to reconsider the conformity election;

• Bank may be in the position to accelerate tax bad debt deduction;• Bank utilizes specific reserves on its financial statements instead of taking a charge-off;• The relationship with the primary regulator has changed and it is becoming more difficult to

obtain the express determination letter;• Administrative burden - conformity election can cause administrative pains, including the

requirement to obtain the required express determination letter (discussed below) during every federal regulatory examination

• All payments received while the loan is in non-accrual status must first be applied to taxable interest income (rather than loan principal);

• The conformity election may create issues with “credit loss” charge-offs on other than temporary impairment (“OTTI”) security write-downs. That is The conformity election may create an issue because the OTTI deduction is not a “charge-off” that decreases the financial statement allowance for loan losses. This area of tax law is also evolving, and there is limited guidance on the issue;

• The conformity election may create issues with in-substance foreclosures. The concept of in-substance foreclosures only applies for regulatory and GAAP purposes (i.e., there is no tax transaction since the bank still holds the loan and no transfer of property occurs). Since the loan is still outstanding for tax purposes, the write-downs of the value of the collateral during the holding period are deductible charge-offs of the loan for tax purposes.


Controversy• California. California FTB Legal has privately taken an aggressive position

that California never conformed to IRC Sec. 166 bad debt conformity election;• The FTB is currently auditing several California financial institutions with bad debt

conformity election;• The FTB may also have taken a position that the safe harbor for non-accrual (e.g.

forgone) interest may not apply to taxpayers with bad debt conformity election;- Internal Revenue Service

- Industry Directive on the Conformity Election for Bank Bad Debts - December 12, 2001 (revised on November 27, 2013);

- On March 17, 2010 the IRS Large and Midsize Business Division (LMSB) has issued a directive (LMSB-04-0110-003) regarding when a lender can stop accruing interest related to non-performing loans for U.S. federal tax purposes.

MY 5 FAVORITE METHODS PLANNING ITEMS

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IRS EXAMINATION UPDATE

COMMENTS FOR COMMUNITY BANKS TO SUPPORT PRIOR PRESENTATIONS

BAD DEBTS INTEREST ACCRUAL ON NONPERFORMING LOANS OREO COSTS SELLING COSTS TRANSACTIONS ISSUES MARK TO MARKET ISSUES 382 LIMITATIONS OTHER

MY 5 FAVORITE EXAMINAITON PLANNING ITEMS

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TRANSACTIONS: IRC Section 382 Planning

A Section 382 ownership change event occurs when a company experiences an over 50% ownership change while it is a loss corporation

A loss corporation is any corporation with a carryforward of net operating losses, capital losses, or tax credits or with a net unrealized built-in loss (NUBIL) over $10MM

The testing period is three-years or since the last Section 382 ownership change event, if sooner

Applies in stock merger / acquisition context to the target (whose stock was just acquired – usually creating a 100% ownership change for the target company)

Can also apply to the acquirer if a portion of the purchase price consideration is comprised of acquirer stock (keep in mind that the testing period is generally three-years)

Can also apply in equity raise situations; i.e. when issuing stock in a public offering, private placement, or recapitalization

IRC Section 382 Planning

If a loss corporation experiences an ownership change, it must compute its Section 382 limitation by multiplying the fair market value of its stock immediately before the ownership change by the applicable federal long-term tax-exempt rate

The limitation determines how much of the tax attributes that existed at the date of the ownership change may be used annually after the ownership change

If at the time of the ownership change, the FMV of a company’s assets exceed the tax basis by more than $10MM then NUBIL restrictions also apply

If NUBIL exists (in excess of $10MM), any assets with built-in losses that are sold at a loss within five years of an ownership change (or one year related to loans) will also be subject to the annual Section 382 limitation on deductibility


In general, in M&A transactions, the risk to the acquirer is that the Section 382 annual limitations will create a situation where a portion of the target’s NOLs will expire

The loss of the value of the future tax benefit will “haircut” the amount of the target’s NOL DTA that will be recorded by the acquirer in “Day 1” accounting

Thus, planning should take place to minimize the impact!


Every situation is different and must be analyzed on a fact specific basis

General stock merger / acquisition planning considerations include:• Shifting losses between periods • Taking advantage of any NOL carryback opportunities• Accelerating income in order to reduce the amount of NOL being carried

forward• If NUBIL applies, delay loan charge-offs until more than one year after the

ownership change


General considerations related to capital raises: • NOL preservation plans

• Also known as a “Shareholder Rights Plan”• A type of “poison pill” plan designed to protect a company's NOLs by discouraging

anyone from triggering a Section 382 ownership change by acquiring 5% or more of its shares

• Places limitations on how many shares can be acquired or creates dilution via preferred shares rights

• Plain vanilla preferred stock is disregarded in determining ownership changes but is taken into account in determining value

Non-Deductible Transaction Costs

Certain transaction costs must be capitalized • To stock related to a stock M&A transactions, or• To assets related to an asset purchase transaction

In general, transaction costs related to stock M&A transactions are permanent adjustment add backs and those related to assets purchases are temporary adjustment add backs

Facilitative costs must be capitalized for tax purposes An amount is paid to facilitate a transaction if, based upon all the

facts and circumstances, it is paid in the process of investigating or otherwise pursuing the transaction


With respect to acquisitive transactions, the final regulations provide an “inherently facilitative” rule and “bright line date” rule

Costs that are “inherently facilitative” are required to be capitalized, whereas other costs, which may facilitate the transaction (but are not inherently facilitative), are required to be capitalized only if they are incurred on or after a certain date

Amounts are inherently facilitative if they are paid to: 1. Secure an appraisal, formal written evaluation, or fairness opinion; 2. Structure the transaction (including the negotiation of the structure and the

obtaining of tax advice on the structure); 3. Prepare and review the documents that effectuate the transaction; 4. Obtain regulatory approval for the transaction; 5. Obtain shareholder approval for the transaction; or6. Convey property between the parties.


General due diligence costs are not considered inherently facilitative but, rather, are to be analyzed under the bright-line date rule

The bright-line date rule states that costs that facilitate the transaction but are not inherently facilitative must be capitalized if they are incurred on or after the earlier of: • (i) the date on which a letter of intent, exclusivity agreement, or similar

written communication is executed • (ii) the date on which the material terms of the transaction are approved by

the taxpayer's board of directors or appropriate governing officials


Certain costs are deemed not to facilitate a transaction and, therefore, are excepted from the capitalization requirement

These amounts include employee compensation, overhead, and costs paid to integrate the business operations (such as software conversion costs)

Success Based Fees

Rev. Proc. 2011-29• In order to eliminate controversy over allocation of portion of success-

based fees that are paid to facilitate transactions and thus are presumed to be capitalized rather than deducted in year paid, IRS established a safe harbor to permit taxpayers to elect to treat 70% of the costs paid as non-facilitative

• Only applies to success based fees (vs. other transaction costs)• Only applies to the portion of the (investment banker) fees that are

“success based.” I.e. does not apply to a fairness opinion or reimbursed costs that may also be included in the same contract

Success Based Fees

Nonrefundable milestone payments (such as a fee paid upon shareholder approval or at the signing of a merger agreement) that are creditable to success-based fees are not in themselves success-based fees and so they won't qualify for safe harbor

IRS asserts that milestone payments are not success-based fees because they are not contingent on the successful closing of a transaction

Therefore, they are not eligible for the safe harbor. Instead, a taxpayer would have to establish, based on all the facts and circumstances, whether the activities were facilitative or not (i.e. the investment banker would need to provide a detailed accounting of his/her time)

Section 280G

Corporations undergoing a change in control are denied deductions for any and all excess parachute payments / "CIC benefits“

In addition, the recipient-individual of these payments must pay an extra 20% excise tax in addition to regular taxes

The employer must withhold the excise tax if the payment constitutes “wages”

CIC clauses can be found in any type of employment agreement or plan (Stock based, SERP, SCP, Split Dollar Life Insurance, etc.)

Section 280G

In general, a payment is a "CIC benefit“ if the payment would not have been made had no change in ownership or control occurred even if the payment is also conditioned on the occurrence of another event

Also applies to the acceleration of payments Special considerations exist regarding:

• Whether benefits are vested or not• Whether there was an acceleration of benefits requiring future

performance• Whether there was an acceleration of benefits based on contingent vesting• Valuing such benefits• Establishing the present value of such benefits

IRC §280G – Overview

If the value of the "CIC benefits“ to a individual, in present value dollars, equals or exceeds three times the individual’s taxable compensation over the five years preceding the year of the transaction, then the individual will be subject to the excise tax and the corporation will lose deductions

The amount that is nondeductible and subject to the excise tax, called the excess parachute payment, equals the value of the payments less one times the individual’s average compensation (base amount)

MY 5 FAVORITE TRANSACTIONS PLANNING ITEMS

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Final Comments: Transactions

STRUCTURE OF THE DEAL OPTICS OF THE DEAL ATTRIBUTES OF THE DEAL PARTNERSHIPS IN THE DEAL WHAT IN THE WORLD DOES THIS MEAN? FROM ARTICLE WRITTEN EARLY IN 2014:

• For 30 years, I have advised clients (and have been a client) on tax opportunities in acquisitions. Whether the opportunity represents the once in a career “double the size” merger (I’ve had five) or the acquisition of assets of a small business or anything in between, deals that have been most successful have all had four common traits:


STRUCTURE OF THE DEAL (ARTICLE TO CLIENTS EARLY 2014):• The structure of the deal and tax effects on companies and stakeholders

are understood by all. As obvious as this may sound, too often the effects to stakeholders (owners, employees, companies) are not completely understood.

• Communication of expected tax results is critical to the deal’s success. Mergers of public companies have extensive public disclosure. Disclosures can be helpful but are often hard to understand. In other deals, less information may be available to understand the expected results.

• While the structure is the most watched aspect of transactions, tax issues/exposures in a deal need to be addressed in two areas: possible issues associated with the transaction itself (discussed in part above) and issues associated with the target business.


OPTICS OF THE DEAL (ARTICLE TO CLIENTS EARLY 2014): The effects of the transaction on financial statement presentation

(and on regulatory capital and position if applicable) will be as important as the actual cash tax effect of any planning done. In some transactions, the optics of the transaction to the seller and to its owners is a driving force and will take priority over everything else in a deal.

Most often, the result of the acquisition to tax rates and deferred tax assets/liabilities can be severely impacted. In other cases, the impact of costs and nondeductible deductions can make the combined business tax position very untenable.

Optics will be critical. The deal optics cannot be overlooked


ATTRIBUTES OF THE DEAL (ARTICLE TO CLIENTS EARLY 2014): After the last few difficult years in the economy, many financial

institutions have limitations on certain tax attributes. In fact, the optimum attributes planning requires knowing which ones are the most key and how to utilize them to full advantage (if positive) or to neutralize and defend against them (if negative).


PARTNERSHIPS (ARTICLE TO CLIENTS EARLY 2014): The most successful transactions are those where the parties work

together before and after an agreement is signed, all the way to the close. Agreements should have language that protects the parties. Yet the parties (and any advisors) who take actions that take advantage of the other party can poison the deal and kill the chance to be partners on opportunities (see below).

Great deals occur when the buyer seeks to incorporate the best ideas and people from the target.


PARTNERSHIPS (ARTICLE TO CLIENTS EARLY 2014): in one of the “double’ transactions noted above, our company

received advice that the golden parachute costs could be avoided completely by following a provision in the Treasury Regulations that allowed the “acquired” (certain unissued) shares of the target to be included in the balance of shares by each party (for Golden Parachute Rules only).

Rather than dismiss the suggestion, we embraced it and accepted legal advice from the Targets’ attorneys. On exam, the position taken was confirmed and upheld by the Revenue Agent resulting in $150 million more capital. And I learned a great lesson: never accept a golden parachute cost if partnering can eliminate such a cost.

Federal Tax Rate Planning

Tax-exempt income • Municipal bonds• BOLI • Tax Exempt Loans

• IMPORTANT!! Maintain IRS Form 8038 as documentation• Governments and municipalities• Political subdivisions• Non-profit (501(c)(3)) construction loans• Non-profit (501(c)(3)) “conduit” loans – where a government agency acts as a

conduit between the 501(c)(3) and the bank

Multi state tax planning / state tax credits


Credits and Incentives• Solar Tax Investments• New Markets Tax Credit • Qualified Zone Academy Bond (QZAB)• Hiring Credits


Alternative minimum tax impact considerations• Most tax-exempt income (e.g. BOLI, Tax Exempt Loans) is an add back

item for arriving at alternative minimum taxable income• Some tax credits cannot be used to offset AMT• Thus, current taxes may be higher than anticipated if AMT exceeds regular

tax• The payment of AMT generates an AMT credit (i.e. it is a temporary

difference) so it does not have an impact on the tax rate • However, be careful not to underpay estimates and extension payments

Deferred Tax Implications of Final Basel III Rules –Tier 1 Capital Considerations

• Current Rules Recap – Disallowed DTA• Net DTA less amount supported by loss carrybacks = DTA dependent on future

taxable income

• Disallowed DTA = DTA dependent on future taxable income reduced by lessor of (a) DTA realized over next 12 months based on future projections or (b) 10% of Tier 1 capital


• New rules: More complex• From net DTA, exclude amounts adjusted out of CET1 to avoid duplication.

• Segregate remaining DTA’s into five buckets• DTAs associated with NOLs and credit carry forwards• DTAs that will be realized through hypothetical carryback• All other DTAs• DTLs• Valuation Allowances (if any)


• DTAs associated with NOLs and credit carry forwards, net of valuation allowances, are deducted from CET1.

• Other DTAs not realized through hypothetical carryback, net of related valuation allowance and DTLs, and that exceed 10% of CET1, are deducted from CET1.

• Net DTAs, mortgage servicing assets, and investments in other financial entities are combined and subject to overall limitation of 15% of CET1.


• Tax related capital deductions phased in• 2015 – 40%• 2016 – 60%• 2017 – 80%• 2018 – 100%

• Risk weighting• DTAs supported by hypothetical carryback: 100%• Other DTAs not otherwise limited by deductions: 250%


• Tax Planning • Reductions of DTAs• Conversions of Carry forwards

• Additional Complexities • Ambiguous Guidance for Deferred Tax Liability Netting

• DTL netting before or after hypothetical carryback? • DTL netting before or after elimination of DTA related to carry forwards?• Consistent manner of netting should be applied period to period

• State by State Computations for Deferred Taxes (e.g. no blended rate can be used)

GAAP Update: Objectives of the Revenue Standard

Remove inconsistencies and weaknesses in existing standards to improve comparability between industries

Provide more useful information through improved disclosure requirements

Provide a more robust framework for addressing revenue issues Simplify the preparation of financial statements by reducing the

number of standards to be applied down to one revenue framework

60

GAAP Update: Scope of the Revenue Standard

Applies when there is a customer, an entity, and a contract (contract does not have to be reduced to writing)

Does not apply to:• Lease contracts• Financial instruments (ie. loans receivable, debt and equity securities,

derivatives, etc.)• Insurance contracts issued by insurance entities (ASC 944)• Financial guarantees (other than product or service warranties)• Non-monetary exchanges between entities in the same line of business to

facilitate sales to customers NOTE: Some contracts may be partially in scope of this standard,

and partially in scope of another ASC Topic

61

Point-in-time vs. Over Time – Banking Examples

62

Revenue Recognition Standard - Adoption

Public Business Entities: Fiscal years and interim periods within those years beginning after 12/15/2016 (No early adoption)

All other entities: • Fiscal years beginning after 12/15/2017• Interim periods within fiscal years beginning after 12/15/2018• Can adopt early, at same time as Public Business Entities

Transition Options:• Full Retrospective, OR• Cumulative Effect Adjustment

63

Revenue Recognition – Tax Considerations

Changes in book/tax differences Possible change in tax accounting methods Revenue-based apportionment factors used for state and

local calculations Changes to amount and timing of revenue recognition

may impact transfer pricing• Need to reconsider transfer pricing strategy and documentation

64

ASU 2014-01, Investments – Equity Method & Joint Ventures (Topic 323)

Qualified Affordable Housing Projects Issued January 2014 Effective dates

• Public – Annual periods & interim reporting periods within those periods beginning after December 15, 2014

• Other entities – Annual periods beginning after December 15, 2014 & interim periods within annual periods beginning after December 15, 2015

Applied retrospectively to all periods presented Early adoption is permitted Does not apply to other tax credit investments

• Historic Tax Credits• New Market Tax Credits

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Accounting for Affordable Housing Projects: Current U.S. GAAP Elect to account for investment using the effective yield method if all

conditions are met• Availability of tax credits allocated to investor is guaranteed by a

creditworthy entity through a letter of credit, tax indemnity agreement or similar arrangement

• Investor’s projected yield based solely on cash flows from the guaranteed tax credits is positive

• Investor is a limited partner for both legal and tax purposes and liability is limited to capital investment

If not using effective yield method, either the equity method or the cost method is required• Equity method or cost method recognizes loss above the line and tax

benefit below the line

66

Accounting for Affordable Housing Projects: Main Difference from Previous GAAP To apply new standard, all of the following conditions must be met

• Probable the tax credits will be available• Lack of significant influence• Substantially all benefits from tax credits & other tax benefits• Positive projected yield based solely on tax benefits• Limited liability investor

Intent is to allow for a net presentation of the investment and tax benefits• Amortization of cost of investment and tax benefits all recognized as a

component of income tax expense (benefit)

67

Accounting for Affordable Housing Projects: Proportional Amortization Initial cost amortized in proportion to the tax credits & other tax

benefits allocated to the investor• Initial investment less expected residual multiplied by percentage of actual

credits & benefits divided by total expected credits & benefits

68

Accounting for Affordable Housing Projects: Proportional Amortization Method

Year Net Investment(1)

Amortization of Investment

(2)

Tax Credits(3)

Net Losses/TaxDepreciation

(4)

Other Tax Benefits(5)

Tax Credits and Other Tax Benefits

(6)

Tax Credits and Other Tax Benefits, Net of Amortization

(7)

1 90,909 9,091 8,000 7,273 2,909 10,909 1,818

2 81,818 9,091 8,000 7,273 2,909 10,909 1,818

3 72,727 9,091 8,000 7,273 2,909 10,909 1,818

4 63,636 9,091 8,000 7,273 2,909 10,909 1,818

5 54,545 9,091 8,000 7,273 2,909 10,909 1,818

6 45,454 9,091 8,000 7,273 2,909 10,909 1,818

7 36,363 9,091 8,000 7,273 2,909 10,909 1,818

8 27,272 9,091 8,000 7,273 2,909 10,909 1,818

9 18,181 9,091 8,000 7,273 2,909 10,909 1,818

10 9,090 9,091 8,000 7,273 2,909 10,909 1,818

11 6,666 2,424 7,273 2,909 2,909 485

12 4,242 2,424 7,273 2,909 2,909 485

13 1,818 2,424 7,273 2,909 2,909 485

14 1,818 5,451 2,183 2,183 365

15

Total 100,000 80,000 100,000 40,000 120,000 20,000

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Accounting for Affordable Housing Projects: Proportional Amortization Method (1) End of year investment for a 5% limited liability interest in the

project net of amortization in column (2) (2) Initial investment of $100,000 x (total tax benefits received during

the year in column (6)/total anticipated tax benefits over the life of the investment of $120,000)

(3) 4 % tax credit on $200,000 tax basis of underlying assets (4) Depreciation (on $200,000 tax basis of underlying assets) using

the straight-line method over 27.5 years up to the amount of the initial investment of $100,000

(5) Column (4) x 40% tax rate (6) Column (3) + Column (5) (7) Column (6) – Column (2)

70

FASB’s Adoption of Private Company Council Proposed Accounting Standards: Background GAAP has gotten more complex in the last 10 years FASB Chair, Russ Golden, has outwardly indicated the Board has as

an objective of “reducing complexity and promoting simplification” of GAAP over the next three years

FASB finished 2013 with ASU 2013-12, Definition of a Public Business Entity• Laid the groundwork for them to entertain and adopt new standards during

2014 going forward that were proposed by the Private Company Council

71

Private Company Council – New ASUs

ASU 2014-02 – Accounting for Goodwill

ASU 2014-03 – Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps

ASU 2014-07 – Applying VIE Guidance to Common Control Leasing Arrangements

72

Leases Project - 2014

More than 600 comment letters received on the 2013 exposure draft Overarching theme of the feedback was concern over the cost &

complexity of applying the proposal with little benefit to the users of the financial statements• Cost to periodically reassess lease assets and lease liabilities due to

changes in lease term, or rate and index-based variable lease payments Final standard expected in 2015 Likely have an effective date for fiscal years 2017 or 2018

73

ASC 860: Transfers and Servicing

New GAAP related to analyzing and accounting for repurchase agreements• ASU 2014-11 requires repurchase-to-maturity agreements to

be accounted for as secured borrowings instead of as sales Evaluate each transfer separately Evaluate all related documents contemporaneously

• Subordination agreements• Servicing agreements• Collateral assignment agreements• Repurchase agreements

74

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Questions?

Randy J. ChurchillDirector– Seattle, Washington(206) 302-6737

Kristine HoeflinSenior Manager – Everett, Washington(425) 303-3007

Louise HansonPartner – Everett, Washington(425) 303-3037

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